A Primer on Intra-Corporate Disputes

A Primer on Intra-Corporate Disputes

Chisum et al. v. Campagna et al., No. 406A19 (N.C. Supreme Court, March 12, 2021).

Disputes among members of LLCs, or shareholders in corporations, arise frequently and can become exceptionally messy. All sorts of claims can be brought, and they can be very difficult to sort out. The North Carolina Supreme Court’s decision in Chisum v. Campagna illustrates the various claims that frequently arise, and provides guidance for lower courts and litigants on the resolution of those claims. As such, it is an important decision for business litigation lawyers and clients alike.

A. Brief Factual and Procedural Overview 

Chisum v. Campagna was a dispute between three people:  Mr. Chisum, on the one hand, and Rocco and Richard Campagna on the other, concerning their membership interests in three related limited liability companies.  The LLCs had been formed in the 1990s to develop commercial real estate in Wilmington. In 2012, however, Chisum alleged that the Campagnas seized control of the LLCs and diluted his interests to the point that they were extinguished.

Mr. Chisum did not file suit, however, until four years later - - July of 2016 - - in the North Carolina Business Court. He alleged numerous claims, including conversion, unfair and deceptive trade practices, unjust enrichment, declaratory judgment, and judicial dissolution of the LLCs. He also sought compensatory and punitive damages.  

The case proceeded to trial in August of 2018, and was tried for a week, resulting in a Judgment requiring the Campagnas to pay compensatory and punitive damages, as well as ordering judicial dissolution of two of the LLCs and the appointment of a Receiver for the third.

B.  Issues and Supreme Court Holdings 

  1. Standard of Review.  

The first point to note is that since 2014, appeals from final judgments in the Business Court go straight to the North Carolina Supreme Court, not to the Court of Appeals.  

The Supreme Court stated that the trial court’s legal determinations, including decisions to grant or deny motions to dismiss for failure to state a claim, as well as the correctness of its jury instructions, are reviewed using a de novo standard of review, i.e., no deference to the trial court decision. On the other hand, discretionary decisions - - such as whether to dissolve an LLC or appoint a Receiver - - are reviewed using the more deferential abuse of discretion standard.  

  1. Statute of Limitations for Declaratory Judgment Claims.

Among Mr. Chisum’s claims was a claim for declaratory judgment that he continued to own interests in each of the LLCs. The trial court resolved that claim via a Motion for Summary Judgment, concluding that the declaratory judgment claims were not subject to any statute of limitations, given that the Amended Complaint alleged an actual controversy between the parties over their respective rights and obligations as members of the LLCs. The Trial Court believed that the timeliness of a declaratory judgment claim is more appropriately challenged through the assertion of a defense of laches.  

On an appeal to the Supreme Court, both sides made various arguments. Chisum argued that statutes of limitation simply do not apply to declaratory judgment claims. The defendants argued that the three-year statute of limitations applicable to breach of contract claims should apply since the declaratory judgment claims depended upon the Operating Agreements, which were contracts. The defendants also argued that the limitations period should begin to run at the time of the breach, regardless of the extent, if any,  to which the non-breaching party (Mr. Chisum) had notice that any breach had actually occurred. In sorting these arguments out, the Supreme Court held as follows:  

  • The statute of limitations applicable to declaratory judgment claims is the statute of limitations that governs the substantive right that is most closely associated with the declaration that is being sought. In this case, the statute of limitations most closely associated with the declaration being sought was the statute of limitations for breach of contract claims (three years), and accordingly, the Supreme Court held that the three-year statute of limitations applicable to contract claims governed the declaratory judgment claims at issue in this case. 
  • Next, the Supreme Court held that the statute of limitations for a breach of contract claim begins to run when the non-breaching party knows or reasonably should have known, that the contract has been breached - - in other words, notice of the breach, rather than the breach itself, is what starts that statute of limitations running. 
  1. Necessity of Proof of Actual Damages in Claims for Breach of Fiduciary Duty and Constructive Fraud.

Mr. Chisum’s claims included individual and derivative claims for breach of fiduciary duty and constructive fraud. The defendants argued that there was no evidence of actual damages and that the lack of damages was a fatal deficiency.  

The Supreme Court had never before addressed the issue of whether a plaintiff was required to prove actual damages to support a claim of breach of fiduciary duty or constructive fraud. After reviewing several Court of Appeals decisions on that topic, the Supreme Court held that potential liability for nominal damages (e.g., $1.00) is sufficient to establish the validity of claims for breach of fiduciary duty and constructive fraud, and can support an award of punitive damages associated with those claims. In other words, actual damages are not required for those claims. The potential for nominal damages will suffice and will support an award of punitive damages if the defendant is liable on the claim.

The Supreme Court also noted that the statute of limitations applicable to breach of fiduciary duty claims is three years, §1-52(1), while the statute of limitations applicable to constructive fraud claims is ten years, §1-56(a).  

Finally, the Court also noted the difference in the elements for these two claims. “The elements of a claim for breach of fiduciary duty are (1) the existence of a fiduciary duty; (2) breach of that fiduciary duty; and (3) that the breach of fiduciary duty was the proximate cause of injury to the plaintiff.” By contrast, the elements of a constructive fraud claim are (1) facts and circumstances that created the relation of trust and confidence between the parties; (2) which led up to and surrounded the consummation of the transaction in which the defendant is alleged to have (3) taken advantage of his position of trust, to the hurt of the plaintiff. Although the elements of those claims overlap, each is a separate claim under North Carolina law. The distinction is that constructive fraud claims require a showing of benefit to the defendant.  

  1. Defense of Open, Fair, and Honest Conduct.

One of the defenses for someone accused of breach of fiduciary duty or constructive fraud is that their conduct was open, fair, and honest. The trial court refused to give a jury instruction on that topic, and the defendants argued on appeal that the omission of their proposed instruction was an error.  

First, the Supreme Court observed that when an appellant court is asked to review jury instructions for error, the instructions must be considered and reviewed in their entirety, and with respect to a particular instruction, an appellate court considers whether the instruction requested is correct as a statement of law, and if so, whether the requested instruction was supported by the evidence.  

In this case, the requested jury instruction on open, fair, and honest conduct did not include the necessary burden shifting language. The law is that where a superior party obtains a possible benefit through the alleged abuse of a confidential or fiduciary relationship, the aggrieved party is entitled to a presumption that a breach of fiduciary duty or constructive fraud took place. However, the accused party is entitled to rebut that presumption by showing, for example, that the confidence reposed with him was not abused. Finally, once the presumption is rebutted, the presumption of fraud evaporates, and the accusing party bears the burden of producing evidence of actual fraud.  

In this case, the proposed jury instruction said in substance that if the jury found that the defendants had acted openly, fairly, and honestly in their dealings with them, Mr. Chisum would then be completely barred from obtaining a recovery on the basis of his constructive fraud claim. It should have informed the jury that if the defendants showed that their conduct was open, fair, and honest, Chisum would still have been entitled to a recovery in the event that the jury found that the actual fraud had occurred. Accordingly, because the proposed jury instruction did not state the law accurately, it was properly rejected.

C.  Identical Compensatory Damages Awards 

The jury awarded nearly $130,000 to one of the LLCs against each of the two Campagnas. On appeal, the Campagnas argued that the identical awards against each of them created an impermissible ambiguity in the verdict. The Supreme Court rejected this argument, noting first that a verdict should be certain and import a definite meaning free from ambiguity, and that as a general proposition, reviewing courts presume that the jury followed the trial court’s instructions. For that reason, appellate courts have held jury verdicts to be fatally ambiguous only where the verdict sheet or the underlying instructions were vague, making it unclear precisely what the jury intended by its verdict.  

The Supreme Court had never had an opportunity to directly address the validity of identical compensatory damage verdicts returned against different defendants. In this case it held that the trial court did not abuse its discretion by refraining from deciding that the jury’s compensatory damages verdict with respect to the LLC was impermissibly ambiguous. The Campagnas had not been held to be jointly and severally liable, and according to the trial court, the combined compensatory damages were still well within the range of compensatory damages sought. Moreover, the verdict sheet and the jury instructions did not contain any language that could reasonably have been expected to confuse the jury as to the effect of any damage award that it intended to make, so there was no basis for believing that the jury failed to act in accord with the Trial Court’s instructions.    

D.  Judicial Dissolution and Appointment of Receiver 

The Defendants’ last argument on appeal was that the trial court erred by judicially dissolving two of the LLCs and appointing a Receiver to handle the operation and dissolution of those LLCs.  

Under §57D-6-02(2), a Superior Court may dissolve an LLC in a proceeding brought by a member if it is established that:  (1) it is not practicable to conduct the LLC’s business in conformance with the operation agreement and Chapter 57D; or (2) liquidation of the LLC is necessary to protect the rights and interest of the member. If the trial court determines that an LLC should be dissolved for reason number 2 (liquidation necessary to protect member’s rights and interests), the statute provides that the other members must be given an option to purchase the ownership interests of the complaining member at fair value, in accordance with any procedures the trial court may provide.  

In this case, Chisum sought judicial dissolution of two of the LLCs under both clauses above, so the defendants were on notice that the trial court could dissolve the LLCs on the basis of either prong of the relevant statute. The trial court’s factual findings, as well as the evidence, contained ample support for a determination that it was not practicable to conduct the LLC’s business in conformance with the Operating Agreements and Chapter 57D, and as a result the Supreme Court held that the trial court properly ordered judicial dissolution without giving the Campagnas the opportunity to purchase Chisum’s interests.  

E.  Punitive Damages Awards 

The jury awarded punitive damages in favor of two of the LLCs.  On appeal, Chisum argued that since the Campagnas owned the majority of the interests in the two LLCs, they would otherwise be entitled to receive pro rata distributions that include monies associated with punitive damages awards, and that would be an inequitable result. 

The problem with this portion of the appeal was that a party is not entitled to advance an argument for the first time on appeal, and Chisum failed to make this argument at the trial court level. Accordingly, the Supreme Court held that Chisum had waived the right to seek to have the allocation of the jury’s punitive damages award recalibrated at a later time.  

F.  Individual Claims for Breach of Fiduciary Duty and Constructive Fraud 

Finally, Chisum argued that the trial court had erred by dismissing his individual (as opposed to derivative) claims for breach of fiduciary duty and constructive fraud. The law in North Carolina is that the shareholders cannot pursue individual claims against third parties for wrongs or injuries to a corporation or LLC that result from the diminution or destruction of the value of their stock. There are two exceptions to this general rule:  (1) where there is a special duty, such as a contractual duty, between the wrongdoer and the shareholder; and (2) where the shareholder suffers an injury that is separate and distinct from the injuries suffered by the other shareholders.

Before getting to that issue, however, Chisum was required to demonstrate that he had met the elements recited above for claims for breach of fiduciary duty or constructive fraud. After review of the record, the Supreme Court concluded that Chisum’s individual claims for breach of fiduciary duty and constructive failed because he had not demonstrated that he sustained a legally cognizable injury. Rather, the facts upon which he relied simply described the steps that the Campagnas had taken to deprive him of his ownership interest in the two LLCs, and did not show the sort of injury that was necessary to support individual claims for breach of fiduciary duty and constructive fraud.  

G.  Conclusion 

Intra-corporate disputes between shareholders/members are a mess. There are many different potential claims, in different forms, with different deadlines and elements. Persons who believe that they may have such claims should consult counsel at their earliest opportunity.

Categories

About the Author

Alan M. Ruley

Alan Ruley is a seasoned civil trial and appellate lawyer. He represents clients in a wide variety of disputes in federal and state court, focusing primarily on business litigation, intellectual property, insurance, banking and employment.
Email Alan